Petrobras Is A Good Bet Despite Headwinds

| About: Petrobras - (PBR)

Summary

The government's majority stake is both a blessing and a curse for Petrobras.

The company has shown above average growth in revenues.

The shift towards local oil would reduce the adverse impact of fuel price controls.

With the ever-growing dependence of the world's economies on fuel and energy, companies involved in the petroleum and energy industry never lose their significance in the market. Petroleo Brasileiro (NYSE:PBR) is one such company. It not only fulfills the major fuel needs of its home country, but has a worldwide presence. The company is financially stable, and has been investing in more advanced projects, ensuring future growth in addition to opening up more markets. However, the Brazilian government is a majority shareholder and isn't shy about exercising its control which sometimes has negative effects for Petrobras. Also, being a partially government operated company, the current election results in Brazil are expected to have an effect on the company's administration and share price. Another factor impacting the shares would be any progress on accusations of bribery that a former jailed employee made against certain company officials. The article discusses all these matters in detail.

Company Description:

Petroleo Brasileiro, more commonly known as Petrobras, is a Rio de Janeiro-based Brazilian petroleum company, listed on the NASDAQ. It is involved in the exploration, production, distribution, refining, and sale of crude oil and its derivatives/other energy sources. It is one of the biggest public companies by market capitalization, having a presence in around 30 countries. The Brazilian government has a majority position in Petrobras, owning more than 50% of the stock both directly and indirectly.

According to Reuters, the company owns 16 refineries, 130+ production platforms, 6 biofuel plants, 16 thermoelectric plants, 1 pilot wind farm, 2 fertilizer plants, more than 8000 service stations, and around 30,000 kms of pipelines. By 2009, Petrobras operated 92% of Brazil's total refining capacity and supplied almost all of the refined product needs of third party wholesalers, exporters, and petrochemical companies. Petrobras is also a major player in researching and exploring deep-water petroleum resources.

The company's stock has seen gains of 4.81% over the past 12 months, with a 6.85% gain over the past 3 months. The stock is currently trading at an 18% discount to its 52 week high of $20.65.

Valuation:

PBR's stock is currently trading at 11.67x earnings for the previous 12 months and 7.30x forward earnings, with a market capitalization of $109.44 billion. The current stock valuation together with a PEG (5 years expected) of 0.55 shows that the stock is undervalued. When doing a comparative valuation of Petrobras with its competitors Schlumberger Limited (NYSE:SLB) and Total (NYSE:TOT), this conclusion is further substantiated. A forward P/E (1yr) comparison of the three companies shows that PBR has the lowest forward price to earnings ratio among the three.

Company

Forward P/E (1 yr)

Petrobras

7.30

Schulmberger

15.00

Total

10.03

Thesis & Catalyst:

The company is currently undervalued primarily due to the aversion of investors the Brazilian government's stake. Also, the company might be facing lawsuits as a jailed former employee testifies that some company officials bribed certain government officials to secure contracts. These two factors have combined to create a negative perception about the company, and have also driven the shares below their potential.

The company's growth in profits has been hampered by the government's control over PBR's pricing decisions. Prices of the end product do not compensate for the growth in cost of production and money invested in new facilities and projects. This has resulted in an increase in cost of production over the years, whereas revenue has been declining due to a price cap on fuel prices by the government.

Petrobras has not lost its zeal when it comes to exploring new horizons in the energy industry and has been effectively increasing its investments in new projects worldwide. New projects such as the offshore Libra project, with contracts to secure an FPSO (floating production, storage and offloading vessel) are promising and are expected to add to the company's earnings in the coming years.

PBR's stock price is all set to rise in the future in light of the projected increase in earnings coupled with the projected growth of the company. Investors also view the possible change in country's leadership as a positive, as the new government is less prone to interfere with the workings of the company. This was evident in the increase in the company's share price when opinion polls showed an increase in the popularity of opponent Silva in the coming elections.

Revenue & EPS Outlook

Revenues have remained somewhat stable. For the year ending December 2013, the top line experienced a decline of 1.83% from 2012. This can in part be attributed to the cap on fuel prices levied by the government that does not allow the company to adjust its product's prices in accordance with its cost of production. The company's revenue growth has outpaced the industry average growth rate of 3.5%.

There has also been an increase in cost of production from $107.53 billion to $108.25 billion from 2012 to 2013, due to a significant increase in exploration costs, resulting in a subsequent decline in gross profit. Net income also declined by a 0.91% from 2012 to 2013; however that decline is much less as compared to the 45% decline from 2011 to 2012.

Quarterly earnings in the second quarter declined from $2.99 billion to $2.22 billion year-over-year. Net operating revenues increased from $35.6 to $36.9 billion year-over-year.

On the production side, total oil and gas production increased by 1.7% year-over-year to 2600 MBOE/d in the second quarter this year.

Petrobras has also made capital investments and expenditures equaling $9.38 billion in the 3-month period ending June 2013. The company's cash position is also quite strong at $26.4 billion.

Variant View

While some could view the government's control in Petrobras as a positive for the company, in the current conditions, it is proving more of a setback, since fuel price control limits its revenues. Considering the fact that the company has very solid roots in the petroleum and energy industry, it would take very catastrophic conditions to bring the company down, which seems unlikely.

Also, the current allegations of bribery could damage the company's reputation if substantiated, leading to the payment of penalties and damages. This could result in a negative public image for the company, hence negatively impacting shares.

Bottom line

The biggest negative for Petrobras is continuing government interference. The government's control over fuel prices negatively affects revenues. However, Petrobras has been trying to increase its production from local assets and reduce its reliance on imported oil. This will reduce the negative impact of government control.

According to Reuters, PBR's stock currently has 9 'hold' recommendations, 2 'buy' and 5 'outperform'. No analyst has the stock as an 'underperform' or 'sell'. This is in line with our analysis of the stock and thus it would be prudent to hold on, as the company seems very promising.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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